New Credit-Card Rules Kick In

The good news: Cardholders will get more notice about rate increases. The bad news: Rates are already going up

The first wave of long-awaited reforms to credit-card industry practices began kicking in on Aug. 20. Under the new rules, credit-card issuers now have to give consumers far more notice before raising their interest rates or hiking fees. Before any changes to fees or rates can kick in, credit-card issuers have to give cardholders 45 days' notice. The new laws also make it harder for cardholders to incur late-payment fees; all bills must be sent to consumers 21 days before payments are due.

Back in the spring, with consumer ire mounting, President Barack Obama signed the Credit Card Accountability, Responsibility & Disclosure Act, which placed substantial restrictions on credit-card billing practices.

More protections are coming down the pipeline and will go into effect in February of next year. Among the most important are payment allocation rules, restrictions on marketing to college students, and restrictions on how card companies raise interest rates. Starting in February, card issuers will have to apply any payment above the minimum due to the balance with the highest interest rate. In the past, card companies routinely applied payments to balances with the lowest interest rate, while the higher-interest debt stagnated. Also, any rate hikes will apply only to future purchases, not to existing debt.

For cardholders, that's the good news. The bad news: Card issuers are racing to reevaluate their portfolios ahead of the February deadline. Most noticeably, interest rates have risen. The average variable rate on new cards is hovering at 11.22%, according to Bankrate.com (RATE). That's up from 10.69% in April. "Credit-card companies are bracing for change and have to rethink how they do business," says Gene J. Truono Jr., a managing director at BDO Consulting and former chief compliance officer at American Express (AXP).

Before the rule changes, credit-card companies would widely extend credit and change the terms of that credit to adjust for risk depending on the cardholders' behavior. They were nimble, and would quickly jack up interest rates or slam customers with fees for paying late or exceeding their debt limits. In fact, the card industry's business model depended on the ability to change terms. And card companies grew fat on fees. Industry analyst R.K. Hammer found that penalty-fee income rose 43% between 2003 and 2008, reaching $19 billion last year.

Banks Pull Back Credit Lines

Now that era of abundant fees and flexibility is over. Banks will be far pickier about who they let in their doors; gone are the days of the credit bonanza. Since banks can't adjust terms as easily or quickly, they will make sure to adjust rates and credit limits to reflect risk at the outset. "The companies will start front-loading the process," says Moshe Orenbuch, an analyst with consultancy Credit Suisse (CS).

Already, a number of the major firms are contracting credit lines. Available lines of credit were cut by nearly $500 billion overall in the fourth quarter of 2008, estimates Meredith Whitney, an industry analyst. That contraction will only continue. Also going down—by 70% from a year ago—is the volume of new-card mail solicitations.

That reflects another reality of the new credit-card landscape: the demise of the teaser rate. Big card-issuing banks such as JPMorgan Chase (JPM), Citigroup (C), and Bank of America (BAC) can't afford to offer super-low rates because they no longer have the same flexibility to change terms on the fly and jack up interest rates on riskier borrowers. Now companies will have to compete on the basis of better products, priced more realistically for risk, rather than enticing cardholders with flashy, short-lived rates.